1099-A Sales Price

[Auto]

I'm still confused about the selling price when the taxpayer receives a 1099-A on a foreclosure. TTB bottom of pg 14-11 defines Sales Price on a Recourse loan as the "Lesser of outstanding debt reduced by any amount for which the taxpayer remains liable, or FMV or property". My client is filing Chapter 13 and is liable for the whole loan. Yet the IRS people I spoke to insist it doesn't matter and the 1099A should be treated as a sale using the outstanding debt as the sales price.

If the taxpayer is still going to pay off this loan as part of the Chapter 13 proceedings, then why should the loan bal be used as the sale price?

The IRS publications don't define sale price the same way TTB does. They simply describe it as debt outstanding with no reference to whether it is going to be paid back or not. (other than if it is cancelled the forgiven amount may be recognized as income). TTB makes more sense to me.

Can anyone explain the logic behind recognizing a gain on money you still have to pay back. Any answers would be so appreciated.

[solomon]

I'm still confused about the selling price when the taxpayer receives a 1099-A on a foreclosure. TTB bottom of pg 14-11 defines Sales Price on a Recourse loan as the "Lesser of outstanding debt reduced by any amount for which the taxpayer remains liable, or FMV or property". My client is filing Chapter 13 and is liable for the whole loan. Yet the IRS people I spoke to insist it doesn't matter and the 1099A should be treated as a sale using the outstanding debt as the sales price.

If the taxpayer is still going to pay off this loan as part of the Chapter 13 proceedings, then why should the loan bal be used as the sale price?

The IRS publications don't define sale price the same way TTB does. They simply describe it as debt outstanding with no reference to whether it is going to be paid back or not. (other than if it is cancelled the forgiven amount may be recognized as income). TTB makes more sense to me.

Can anyone explain the logic behind recognizing a gain on money you still have to pay back. Any answers would be so appreciated.

Actually, the IRS Pubs. describe this topic the same as TTB - that is where TTB got that information.

As you describe it from the TTB this the correct way to report the sale for recourse debt. Normally with a foreclosure (1099-A) there is no gain on the sale. However, you did not give any numbers to determine this.

By the way, if you talked with a customer representative at the IRS, never put much stock in the answer to a bit more complex question.

[Auto]

Either huge loss or gain

I hear you about the IRS answers. I did see in pub 4681 under Amt realized and ordinary income on a recourse debt it states "the amount realized on foreclosure is the smaller of the oustanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or the FMV of the transferred property".

The numbers we're talking about are $115,000 basis, outstanding loan bal of $325,000. Also, the property was used as a rental during part of the past 5 years. It was the personal residence for 2 out of those 5 years so he'll get most of the exclusion.

So, with those numbers, the taxpayer is looking at either a huge gain if sale price is $325,000, or a decent loss if sales price is 0.

IRS got me nervous because both agents insisted that no matter what, their computers will pick up the 1099-A outstanding debt as the sales price. Whether the taxpayer is still liable for the debt under a Chapter 13 was irrelevant to them (except that they would then only take the outstanding bal instead of the lower of FMV (which is $380,000) or bal.

Thank you for your reply. I've been pondering this over in my head for over a week and am at a stop on the return.

[solomon]

I hear you about the IRS answers. I did see in pub 4681 under Amt realized and ordinary income on a recourse debt it states "the amount realized on foreclosure is the smaller of the oustanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or the FMV of the transferred property".

The numbers we're talking about are $115,000 basis, outstanding loan bal of $325,000. Also, the property was used as a rental during part of the past 5 years. It was the personal residence for 2 out of those 5 years so he'll get most of the exclusion.

So, with those numbers, the taxpayer is looking at either a huge gain if sale price is $325,000, or a decent loss if sales price is 0.

IRS got me nervous because both agents insisted that no matter what, their computers will pick up the 1099-A outstanding debt as the sales price. Whether the taxpayer is still liable for the debt under a Chapter 13 was irrelevant to them (except that they would then only take the outstanding bal instead of the lower of FMV (which is $380,000) or bal.

Thank you for your reply. I've been pondering this over in my head for over a week and am at a stop on the return.

With the debt being lower than the FMV, there would be a 210K gain which would be excluded under §121 as I understand it. Nevertheless, perhaps the unrecaptured 1250 gain could not be excluded but probably would be moot anyway.

[Auto]

I know. The numbers aren't the norm because the taxpayer used the money for other than acquisitiion and improvements, so his basis is low and the FMV is higher than the loan bal. Also pretty unusual for these days.

Solomon, thank you so much for your response.

[solomon]

I know. The numbers aren't the norm because the taxpayer used the money for other than acquisitiion and improvements...

That would make ponder too.

[Gary2]

I'm still confused about the selling price when the taxpayer receives a 1099-A on a foreclosure. TTB bottom of pg 14-11 defines Sales Price on a Recourse loan as the "Lesser of outstanding debt reduced by any amount for which the taxpayer remains liable, or FMV or property". My client is filing Chapter 13 and is liable for the whole loan.

No, he isn't. What do you think happens to the money raised at the foreclosure sale?

He only remains liable for the amount that isn't paid off by the foreclosure sale. In this case, it sounds like it sold for $380K at foreclosure. If the debt secured by the house was only $325K, then it was fully paid off by the foreclosure. There may be other expenses incurred by the mortgagee that are owed by your client, but probably not $55K worth. You should be asking your client what happened to that balance - which could well be additional taxable income to him; perhaps the bankruptcy trustee has it.

Let's look at the worksheet in Pub 4681:
1. Debt before foreclosure minus amount liable after foreclosure: $325K
2. FMV of the property: $380K
3. Ordinary income from cancellation of debt: none
4. Smaller of line 1 or 2: $325K
5. Proceeds from the foreclosure: Unknown, but possibly as much as $55K
6. Total: As much as $380K
7. Basis: $115K (ignore the rental depreciation for now, just to show how this works)
8. Gain: as much as $265K

[Auto]

It hasn't sold for anything yet and the taxpayer believes there isn't a remote possibility for it to sell at $380,000. Judging by what real estate is going for in Florida these days he's probably right. A court hearing with the bank brought the amount owed up to $372,000. Your explaination was very clear. At this point, the guy has walked away with $325,000, of which only $115,000 went into the basis of the property. As it stands right now, he has a gain.

But what if he actually pays this back down the road through his Chapter 13 payment plan. What happens then? He's already paid taxes on money he's now returned. Am I just pondering on something that would never really ever happen?

[Gary2]

It hasn't sold for anything yet

A foreclosure is a sale - typically an auction sale. The amount in box 4 is usually the winning bid at the auction. If it were an abandonment, box 4 should have been blank.

Perhaps you're getting confused because the mortgage holder won the auction. It's common for mortgage holders to bid at the foreclosure sale to protect their interests. Although the auction defines FMV legally, as a practical matter, they may get more by putting it up for sale through a regular real estate listing. In more normal times, mortgage holders would bidan amount close to the balance due on the loan. If they lose the auction, they recover the balance due on the loan from the new buyer. If they win the auction, they turn around and list it with MLS, hoping to get more than they would have gotten from a third party at the auction. Unless there's some peculiarity in state law, they can't go back to the borrower to recover the difference between what they paid at auction and what they eventually sell it for.

One of the factors that accelerated the mortgage and banking crisis is that banks would continue this approach, believing - just like consumers - that the property was worth more than it really was. This left many banks and mortgage companies with an unacceptable inventory of homes they couldn't sell for what they wanted. I guess it's possible there are some banks that are still overestimating values.

[Auto]

Thank you Gary2. That does make sense. It would certainly be a great deal for the banks if they got the property back, plus whatever sale proceeds they can get, and then on top of that, they continue to get loan payments through the Chapter 13. The taxpayer believes this to be the case. He had me believing it as well which is what confused me about the logic of the tax law. I know as little about bankruptcy as the taxpayer does. Thank you again for your help. I can finally put this aside.